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What happens to unpaid debt when a person passes on? Find out how to protect you and your loved ones from facing creditors during an already difficult time.
When a family member dies, their unpaid debts are typically paid out of their estates. If you’re a beneficiary of the estate, any obligations owed by the deceased will be paid before any proceeds will be distributed to you or any other heirs.

But what if there’s no estate, or if the assets in the estate are insufficient to pay the obligations? Is it possible that you, as a family member, will inherit the debt of the deceased person?

There are laws governing exactly how the debts of decedents are handled. They vary from one state to another, so we’ll cover the topic only in the most general terms.

Which Family Members can Inherit Your Debt?

When it comes to the debt of a deceased person, liability will depend on the relationship. For example, children and grandchildren, as well as other family members, are not legally responsible for the debts of the deceased. However, if you cosign a loan with the deceased, you will be legally obligated to make good on the debt.

Spouses, on the other hand, may be liable depending on your state of residency and the type of debt involved.

If you live in a community property state, you as the spouse will be responsible for any unpaid debts, particularly those incurred since you were married. For example, if your spouse has a car loan, a couple of credit cards and business debt, you will be liable for those debts.

Community property states include Arizona, California, Idaho, Louisiana, Nevada, New Mexico, Texas, Washington and Wisconsin. If you are not a resident of a community property state, your obligations for your deceased spouse’s debts will depend on individual state law. Naturally, any loans you are jointly obligated to pay will be your responsibility regardless of which state you live in.

What Happens if You Don’t Pay the Deceased Person’s Debts

If you are legally liable to pay the debt of the deceased, a creditor will pursue you the same way they would for any other type of debt.

If a payment hasn’t been made in a while, the account will most likely go to collection. That will appear on your credit report, in addition to the fact that you will be harassed by the collection agency on a regular basis. This will include a combination of threatening letters and phone calls.

If you fail to settle the collection account, the creditor can pursue a judgment against you. If they do, they can garnish your wages and/or your bank accounts.

If you are retired, the creditor may be unable to pursue you. For example, a creditor cannot garnish income from Social Security, veteran’s benefits, or federal and civil service retirement benefits. As well, defined contribution retirement plans, like 401(k) plans, are exempt from creditor claims. And in most states, IRAs are also exempt.

However, be aware that other property may be subject to garnishment. That can include pension income, earned income, non-retirement savings and investments, and equity in real estate.

Even if you don’t have any income or assets that a creditor can attach, they may continue to hound you for payment. And if you do come into attachable income or assets in the future, the creditor may pursue those.

Related: How Becoming a Widow Affects Credit

Secured Loans

Be aware that a creditor can seize property that serves as collateral for a loan. For example, let’s say you and your spouse jointly own a house and a car. There’s a loan on both, and in each case the loan is in the name of your spouse only.

If your spouse dies, you will be obligated to pay both the mortgage and car loan, even though neither obligation is in your name. If you fail to continue making the payments or pay off the debt completely, the lender can foreclose on the house or repossess the car in settlement of the debts.

Under extreme circumstances, your best protection against creditors will be to file for Chapter 7 bankruptcy. However, if you have substantial assets, this won’t be a viable option.

How You Can Protect Your Family Members from Paying Your Debts Upon Your Death

The simplest way to protect your family members from your debts is through a life insurance policy. If you maintain a policy sufficient to pay all your debts upon your death, not only will there be no obligation to your spouse, but it will also ensure your entire estate will be distributed to your designated heirs consistent with your final wishes.

You may also want to avoid any joint or co-signed debt obligations. For example, if anyone cosigns a loan that’s primarily your obligation, they will be legally obligated to pay the debt upon your death. That’s the whole purpose of having a cosigner on the loan.

You should also have a will in place, however. It won’t make your debts go away, but it can be used to list your debts and to make provisions for how they’ll be paid. Naturally, this will only be a benefit if your estate is large enough to cover your debts. If it isn’t, the debts will be only partially paid, but no proceeds will be available for distribution to your heirs. Once again, this is where having a life insurance policy to pay your debts will be the best solution.

If your estate has insufficient assets to cover your debts, the creditors will generally be unable to go after your heirs, except in the case of your spouse in a community property state as described earlier.

As far as the unpaid debts, each state has a priority list of how debts are paid out of an estate. Typically, medical expenses, unpaid tax obligations and funeral costs will be paid ahead of the unsecured creditors, like credit cards. Any debts remaining will need to be written off by the creditors.

Related: The Money Binder: How to Prepare Your Finances For Your Death

Can a Trust Protect Your Family Members from Paying Your Debts Upon Your Death?

Lawyers often recommend trusts to enable an estate to pass from you to your heirs without the need to go through probate. A trust is a very specific legal document that spells out the details of your estate settlement. That will include distribution of assets to intended heirs, as well as payment of any obligations.

There are two basic types of trusts: revocable and irrevocable. Unfortunately, neither type of trust will necessarily protect your family members from your debts. Under either type of trust, payment of debts must be provided for within the trust itself. However, the trust can provide for the pay off of debts as long as the assets in the trust are sufficient to do so.

But the main advantage of a trust over a will is that it avoids probate. When a will is probated, the court notifies creditors of the cutoff date for filing claims against your estate. If creditors failed to file by the deadline, the obligations are canceled.

It may be possible to distribute assets to beneficiaries from a trust prior to paying creditors. However, that won’t prevent the creditors from going after those assets even after distribution.

A trust can give you better control of your estate and avoid probate, but to protect the estate and your heirs from creditors, it needs to be implemented with other strategies.

One is to name specific beneficiaries on certain asset accounts. These can include IRAs, employer-sponsored retirement plans, investment accounts, and of course, life insurance. By naming one or more beneficiaries on each account, the assets will pass to your heirs outside your estate. That will guarantee the designated beneficiary will get whatever share of the asset you choose.

The same is true with bank accounts. You can use a “payable on death” designation, ensuring the direct transfer of the account to the person you designate. You can also set up a joint bank account with right of survivorship. The funds will transfer directly to the co-owner of the account upon your death.

Learn More: Best Online Will Maker

Easy and Affordable Estate Planning Options

As you can see, protecting your family members from creditors upon your death can be a complicated task. It may be necessary to consult with an attorney who specializes in estate planning. But be aware that this will be an expensive option. It’s usually recommended primarily for people with large estates or complicated financial situations. But it can be well worth the money spent.

If your estate is smaller and less complicated, you can use an online service to prepare either a will or a trust. An example is Trust & Will. They can help you set up either a will or a trust that’s specific to your state of residence and for a fraction of what it would cost to use an attorney. They have suggested formats based on your estate situation and state of residence. You can also add custom provisions based on any specific details. Visit Trust & Will

In most cases, you will be able to protect your family members from creditors with advance planning. But it will take several strategies, including creating either a will or a trust and adding direct pass-through provisions on assets, such as naming beneficiaries on specific asset accounts.

Author Bio

Total Articles: 168
"Kevin Mercadante, is a freelance professional personal finance blogger, and the owner of his own personal finance blog, OutOfYourRut.com. He lives in New Hampshire and has backgrounds in both accounting and the mortgage industry."

Article comments

1 comment
Steveark says:

Although it isn’t very commonly enforced, 30 states have filial responsibility laws that obligate children to pay for the basic care needs of their parents no matter their age. So if a parent has run up large health care bills and dies with no money a child could be forced to pay those bills. I think it happens only rarely but there are cases where it has. The provided who is seeking the money can go after only one of the children or all of them and if you are found with the means to pay you can be forced to pay even if you have brothers and sisters who are not sued. This only happens when the bills are larger than the size of the estate.